At regular time intervals, I respond to the question asked by readers of this blog. Many of my post on this blog are inspired by such questions. Today’s post is in response to one such question. It is related to number of equity shares, equity base, and calculating EPS. I will use an example to discussion these aspects. So the question is reproduced below in verbatim.
The nse site, giving financial results,a company mentions about Paid-up Equity Share Capital. Ex For axis bank has 36crore shares ,it mentions equity share capital as 36 crore*10 = 360 crore. What does this mean. because the actual capital raised would be the shares offered to public*ipo price. Will not this be the equity base of a company? and for finding EPS why do we consider the entire number of shares rather than only the number issued to public (since the capital raised would be only that much).
When I form a company, I use my personal capital (i.e invest my own money) into the company and business activities. In the process of forming and registering a new company, according to Companies Act, it needs to be capitalized. Capitalization is the process in which owners have to come with number of shares and its face value.
Typically, per share value used is Rs. 10 (which is face value) and it is multiplied by number of shares or divided by total invested money. In my company, I invested Rs. 5000. Thus the capitalization is as follows:
- Authorized capital is Rs 5000, i.e. 500 shares x Rs 10 per share;
- Paid-up equity capital is Rs 5000. Thus, Rs 5000 becomes the total capital base of my company at the time of registration or inception.
In another scenario, I can say, the capital base is Rs 6000. But I paid only Rs. 5000. Therefore, the capitalization is as follows:
- Authorized capital is Rs 6000 i.e. 600 shares x Rs 10 per share;
- Paid up equity share capital of Rs 5000 i.e. issued capital is only Rs 5000 and issued share is only 500 shares.
Typically, this is also the “value” because it is not generating any profits, its still not established, etc. I will use second scenario for further discussion, because it is very much similar to widely used in actual practice.
Now I work hard and increase the value of my company by branding, market positioning, revenue, profits, future potential, market share, etc. I keep all the profits (and the high net worth), because I am the only one having paid-up equity capital. The total earning is divided by 500 shares. EPS is based on 500 shares that are issued to me.
Remember, according to my authorized capital, I still have 100 shares at face value of Rs 10 remaining to be issued. They are not yet issued or not been paid up, and hence cannot be used for EPS.
At some point in future, I decide I need more capital and more investment to grow the business. I can do it in two ways. I could take on debt from banks or other sources, or I could forgo little bit of equity. Debt – I am on hook to repay with interest under all circumstances. Equity – I share proportional profits, loss, and bankruptcy. I decide to raise capital by diluting the equity i.e. I am taking on additional partners. These partners could be rich private investors, financial institutions, or any other public investor. If it is open to common public, then it is called as an open public offer.
Now, at that point in time, the value of my business is much more than Rs 6000. It is an established business with lots of potential. Whoever wants to become partner or stakeholder is getting partial ownership of well established business. The new partner does not have to take the risk. It is for this reason; the “present value” of the business is much more. How to determine the “present value” of the business is a whole new subject.
For simplicity, let us consider that the “present value” of the business comes to Rs 1,20,000. With this increased value of the business, the “market value per share” is Rs 200 [Rs 1,20,000/600 shares].
I decide to let 50 remaining shares go to be public. I use public offering and price my per share value at Rs. 200. I raise Rs 10,000 [50 x 200]. Now the capital structure of my company is as follows:
- Authorized capital is still Rs 6000 [600 shares of Rs 10 each]
- Paid up equity is Rs 5500 [original 500 shares and addition shares of 50]
- Share premium account is Rs 9500 [10000 – 50×10]. This is still considered as part of total shareholder equity. The way it is treated for balance sheet accounting, and how, why, when it is used, is where things become little murky for layman individual investor to understand. For now, just remember the additional money beyond face value is termed as share premium. I will explain this in another post to avoid any complexity in this discussion.
So equity base is not the [IPO price x IPO shares] alone. The owner is only opening partial ownership to raise additional capital for growing the business.
At this point, the total earnings of the company is divided by 550 shares. Because now a total of 550 shares have been issued and paid up equity has increased to 550 shares. Even though the mass public has only 50 shares, it is not the only shares in the company. IPO shares are add-on to existing 500 shares.
I hope this explains the question asked by the reader of this blog. Stay tuned, I will continue this in another post and discuss what happens to share premium account and remaining 50 shares.
Disclaimer: It is likely that a professional accountant or financial expert may disagree with the terminologies I have used or the way I have attempted to explain. I have tried to discuss this in a very layman term so that common individuals can understand. Key here is; this explanation captures the essence of it.
authorized capital, capital base, earnings per share, equity shares, paid-up capital, paid-up equity, share premium account